Elasticity and Its Application

Transcription

1 Elasticity and Its Application

2 Elasticity... is a measure of how much buyers and sellers respond to changes in market conditions allows us to analyze supply and demand with greater precision.

3 Price Elasticity of Demand Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. It is a measure of how much the quantity demanded of a good responds to a change in the price of that good.

4 Determinants of Price Elasticity of Demand Necessities versus Luxuries Availability of Close Substitutes Definition of the Market Time Horizon

5 Determinants of Price Elasticity of Demand Demand tends to be more elastic : if the good is a luxury. the longer the time period. the larger the number of close substitutes. the more narrowly defined the market.

6 Computing the Price Elasticity of Demand The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price. Price Elasticity of Demand = Percentage Change in Demanded Percentage Change in Price

7 Computing the Price Elasticity Price elasticity of of Demand demand Percentagechange in quatity demanded Percentagechange in Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones then your elasticity of demand would be calculated as: ( 10 8) ( ) percent percent 2 price

8 Ranges of Elasticity Inelastic Demand demanded does not respond strongly to price changes. Price elasticity of demand is less than one. Elastic Demand demanded responds strongly to changes in price. Price elasticity of demand is greater than one.

9 Ranges of Elasticity Perfectly Inelastic demanded does not respond to price changes. Perfectly Elastic demanded changes infinitely with any change in price. Unit Elastic demanded changes by the same percentage as the price.

10 A Variety of Demand Curves Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve.

11 Perfectly Inelastic Demand - Elasticity equals 0 Price Demand 1. An increase in price... $ leaves the quantity demanded unchanged.

12 Price Inelastic Demand - Elasticity is less than 1 1. A 22% increase in price... $5 4 Demand leads to a 11% decrease in quantity.

13 Unit Elastic Demand - Elasticity equals 1 Price 1. A 22% increase in price... $5 4 Demand leads to a 22% decrease in quantity.

14 Elastic Demand - Elasticity is greater than 1 Price 1. A 22% increase in price... $5 4 Demand leads to a 67% decrease in quantity.

15 Perfectly Elastic Demand Price - Elasticity equals infinity 1. At any price above $4, quantity demanded is zero. $4 Demand 2. At exactly $4, consumers will buy any quantity. 3. At a price below $4, quantity demanded is infinite.

16 Elasticity and Total Revenue Total revenue is the amount paid by buyers and received by sellers of a good. Computed as the price of the good times the quantity sold. TR = P x Q

17 Elasticity and Total Revenue Price $4 P x Q = $400 P (total revenue) Demand 0 Q 100

18 Elasticity and Total Revenue With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases.

19 Elasticity and Total Revenue: Inelastic Demand Price An increase in price from $1 to $3... Price leads to an increase in total revenue from$100 to $240 $3 $1 Demand Revenue = $100 Revenue = $240 Demand

20 Elasticity and Total Revenue With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases.

21 Elasticity and Total Revenue: Elastic Demand Price An increase in price from $4 to $5... Price leads to a decrease in total revenue from$200 to $100 $5 $4 Revenue = $200 Demand Revenue = $100 Demand

22 Computing the Elasticity of a Linear Demand Curve Price Total Revenue (Price x ) Percent Change in Elasticity Description Percent Change in Price $0 14 $0 200% 15% 0.1 Inelastic Inelastic Inelastic Unit elastic elastic elastic elastic 7 0 0

23 Income Elasticity of Demand Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers income. It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

24 Computing Income Elasticity Income Elasticity of Demand = Percentage Change in Demanded Percentage Change in Income

25 Normal Goods Inferior Goods Income Elasticity - Types of Goods - Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods.

26 Income Elasticity - Types of Goods - Goods consumers regard as necessities tend to be income inelastic Examples include food, fuel, clothing, utilities, and medical services. Goods consumers regard as luxuries tend to be income elastic. Examples include sports cars, furs, and expensive foods.

27 Price Elasticity of Supply Price elasticity of supply is the percentage change in quantity supplied resulting from a percent change in price. It is a measure of how much the quantity supplied of a good responds to a change in the price of that good.

28 Ranges of Elasticity Perfectly Elastic Relatively Elastic Unit Elastic E S = E S > 1 E S = 1

29 Ranges of Elasticity Relatively Inelastic Perfectly Inelastic E S < 1 E S = 0

30 Perfectly Inelastic Supply - Elasticity equals 0 Price Supply 1. An increase in price... $ leaves the quantity supplied unchanged.

31 Inelastic Supply - Elasticity is less than 1 Price Supply 1. A 22% increase in price... $ leads to a 10% increase in quantity.

32 Unit Elastic Supply - Elasticity equals 1 Price Supply 1. A 22% increase in price... $ leads to a 22% increase in quantity.

33 Elastic Supply - Elasticity is greater than 1 Price Supply 1. A 22% increase in price... $ leads to a 67% increase in quantity.

34 Price Perfectly Elastic Supply - Elasticity equals infinity 1. At any price above $4, quantity supplied is infinite. $4 Supply 2. At exactly $4, producers will supply any quantity. 3. At a price below $4, quantity supplied is zero.

35 Determinants of Elasticity of Supply Ability of sellers to change the amount of the good they produce. Beach-front land is inelastic. Books, cars, or manufactured goods are elastic. Time period. Supply is more elastic in the long run.

36 Computing the Price Elasticity of Supply The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price. Elasticity of Supply = Percentage Change in Supplied Percentage Change in Price

37 Application of Elasticity Can good news for farming be bad news for farmers? What happens to wheat farmers and the market for wheat when university agronomists discover a new wheat hybridthat is more productive than existing varieties?

38 Application of Elasticity Examine whether the supply or demand curve shifts. Determine the direction of the shift of the curve. Use the supply-and-demand diagram to see how the market equilibrium changes.

39 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. An Increase in Supply in the Price of Wheat Market for Wheat $3 S 1 Demand of Wheat

40 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. An Increase in Supply in the Price of Wheat Market for Wheat 1. When demand is inelastic, an increase in supply... S 1 S leads to a large fall in price... $3 2 Demand of Wheat 3....and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220.

41 Compute Elasticity E D = ( )/ ( )/

42 Compute Elasticity E D = ( ( )/2 2.00)/ Demand is inelastic

43 Summary Price elasticity of demand measures how much the quantity demanded responds to changes in the price. If a demand curve is elastic, total revenue falls when the price rises. If it is inelastic, total revenue rises as the price rises.

44 Summary The price elasticity of supply measures how much the quantity supplied responds to changes in the price. In most markets, supply is more elastic in the long run than in the short run.

45 Graphical Review

46 Computing the Price Elasticity of Demand Price $5 E D (100-50) (100 50)/2 ( ) ( )/2 4 Demand 67 percent -22 percent -3 Demand is price elastic

47 Perfectly Inelastic Demand - Elasticity equals 0 Price Demand 1. An increase in price... $ leaves the quantity demanded unchanged.

48 Price Inelastic Demand - Elasticity is less than 1 1. A 22% increase in price... $5 4 Demand leads to a 11% decrease in quantity.

49 Unit Elastic Demand - Elasticity equals 1 Price 1. A 22% increase in price... $5 4 Demand leads to a 22% decrease in quantity.

50 Elastic Demand - Elasticity is greater than 1 Price 1. A 22% increase in price... $5 4 Demand leads to a 67% decrease in quantity.

51 Perfectly Elastic Demand Price - Elasticity equals infinity 1. At any price above $4, quantity demanded is zero. $4 Demand 2. At exactly $4, consumers will buy any quantity. 3. At a price below $4, quantity demanded is infinite.

52 Elasticity and Total Revenue Price $4 P x Q = $400 P (total revenue) Demand 0 Q 100

53 Elasticity and Total Revenue: Inelastic Demand Price An increase in price from $1 to $3... Price leads to an increase in total revenue from$100 to $240 $3 $1 Demand Revenue = $100 Revenue = $240 Demand

54 Elasticity and Total Revenue: Elastic Demand Price An increase in price from $4 to $5... Price leads to a decrease in total revenue from$200 to $100 $5 $4 Revenue = $200 Demand Revenue = $100 Demand

55 Perfectly Inelastic Supply - Elasticity equals 0 Price Supply 1. An increase in price... $ leaves the quantity supplied unchanged.

56 Inelastic Supply - Elasticity is less than 1 Price Supply 1. A 22% increase in price... $ leads to a 10% increase in quantity.

57 Unit Elastic Supply - Elasticity equals 1 Price Supply 1. A 22% increase in price... $ leads to a 22% increase in quantity.

58 Elastic Supply - Elasticity is greater than 1 Price Supply 1. A 22% increase in price... $ leads to a 67% increase in quantity.

59 Price Perfectly Elastic Supply - Elasticity equals infinity 1. At any price above $4, quantity supplied is infinite. $4 Supply 2. At exactly $4, producers will supply any quantity. 3. At a price below $4, quantity supplied is zero.

60 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. An Increase in Supply in the Price of Wheat Market for Wheat $3 S 1 Demand of Wheat

61 Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc. An Increase in Supply in the Price of Wheat Market for Wheat 1. When demand is inelastic, an increase in supply... S 1 S leads to a large fall in price... $3 2 Demand of Wheat 3....and a proportionately smaller increase in quantity sold. As a result, revenue falls from $300 to $220.